“The Federal Reserve continues to work actively to prepare for the possibility of financial stress.” — Ben Bernanke, January 5, 2007
Did the Fed Chairman Ben Bernanke know in advance that a financial crisis was coming in 2008?
In an interview for Time’s Person of the Year issue, Bernanke denied knowing that anything serious was amiss. Yet……
Three years ago I was in the audience at a luncheon sponsored by the American Economic Association (AEA), the annual gathering of professional economists. Bernanke gave a speech called “Central Banking and Bank Supervision in the United States.”
As he talked, I noticed that he used the words “panic,” “crisis,” and “stress” over and over again. I reported in my investment newsletter (Forecasts & Strategies, February, 2007): “Anyone reading between the lines could understand that Bernanke is worried about a financial storm ahead….
“In his speech, Bernanke used the terms “crisis,” “panic,” “threats,” “stress” and similar words at least 36 times.”
I concluded: “I doubt if the Fed will cut rates again unless there is an imminent financial crisis of some sort that will require more liquidity and lower rates.”
I met up with the Fed chairman last week at the AEA meetings in Atlanta, where Bernanke gave another speech, this one on “Monetary Policy and the Housing Bubble.”
Before his talk, I showed him a copy of his 2007 address, circling all the “panic” and “crisis” words in his talk. “Did you have a premonition that a financial crisis was coming?” I asked.
He starred at me stoically and smiled. He was noncommittal.
In his official speech, he denied that the Fed’s low-interest rate policy in 2002-04 caused the housing bubble or the financial crisis. The housing boom was global, he said, and couldn’t be blamed on US monetary policy.
However, Bernanke did take some responsibility for the lack of proper banking standards that led to the housing crisis. According to Bernanke, the Fed took steps to regulate the subprime mortgage market, but the new regs were “too little too late.”
Indeed, the evidence is clear now that only the United States (and to some extent the UK) lowered underwriting standards in the real estate market, allowing unqualified housing buyers and “no doc” loans. Countries such as Canada, Australia, and New Zealand refused to permit such lax banking and mortgage business, and did not suffer a financial collapse. In short, the financial crisis of 2008 was home grown in the United States, and the blame for the financial crisis can squarely be placed on the U.S. banking authorities.
After his talk, Bernanke took questions, and I asked the final question: “Mr. Bernanke, foreign central banks like Bank of India and Bank of China are now buying tons of gold. Is this a sign that foreigners are losing faith in the dollar-based world monetary system?”
Again, he had a “What, me worry?” response. “The world financial system is sound,” he responded. He showed no concerns about the dramatic rise in the price of gold since he became chairman, or his "zero interest rate" policy currently in place that is causing the dollar to lose value every day.
Who should take the fall for financial crisis?
If Ben Bernanke were the CEO of a major U.S. corporation, he would be fired for such dereliction of duty. Before the crisis, he repeatedly assured Congress and the public that the Fed was alert to any economic problems that might arise. “To make crises less likely,” he said in his 2007 AEA speech, “over the years the Federal Reserve has worked effectively with the Congress, other supervisors, and financial market participants to develop statutory, regulatory and other measures.”
The Fed has worked “effectively” to prevent crises? Give me a break.
He also said: “With strong private-sector institutions and good public policies in place, episodes of several financial stress should be relatively infrequent.”
Clear he and the Fed blundered….and the Fed chairman should pay the price. He should not be reappointed by the Senate. But of course he will be because Congress doesn’t want to rock the financial markets.
Note: Bernanke also happens to be the co-author of a popular principles textbook in college. Following the rest of the profession, he uses the standard macroeconomic model (the Aggregate Supply-Aggregate Demand or AS-AD model) to predict future booms and busts. How did the standard macro model used by Bernanke and the profession work out in predicting the 2008 crash? Terrible. It actually forecast that 2008 would be a year of higher inflation and higher GDP. In fact, we got the opposite.
I attended a popular session at this year’s AEA meeting on “How Should the Financial Crisis Change How We Teach Economics?” Panelists were from the top ivy league schools of Harvard, Yale, Princeton and Chicago. They all agreed that the standard AS-AD macro model failed miserably to predict the crisis.
Yet none of them could offer a decent alternative model. They were sticking with their defective model. Fortunately, there is a better macro model out there: the "Austrian" model of the business cycle. In my own textbook, “Economic Logic” (Capital Press, 2010), I have proposed a new macro model based on the “natural” rate of interest and the “Austrian” theory of the business cycle. And this model predicted an inflationary boom in the U.S. and global economy that was not sustainable. A crash was inevitable.